The draft regulation, which was first proposed by the European Commission on 4 September 2013, contains new measures that would apply to all Money Market Funds (MMFs), whether UCITS or AIFS, that are established, managed or marketed in the EU.
While the European Commission has proposed the draft regulation, both the European Parliament and the Council of the EU have a role, in accordance with the EU’s ordinary legislative procedure, in negotiating and deciding the final text to be adopted.
The European Parliament referred the proposal to the ECON Committee in September 2013 and Said El Khadraoui was appointed rapporteur with responsibility for the draft regulation.
On 15 November 2013, Mr El Khadraoui issued his draft report in which he proposed a number of amendments to the draft regulation. The most significant of these was that five years after the draft regulation entered into force, all MMFs that operate with a constant net asset value (CNAV) established, managed or marketed in the EU, must convert into a variable NAV MMF.
The draft regulation provides that all CNAV MMFs would be required to establish and maintain at all times a “capital buffer” amounting to at least 3% of the total value of their assets (NAV Buffer). This NAV Buffer should be composed of cash and held in a protected reserve account in the name of the CNAV MMF. Importantly, the draft regulation allows a transitional period for existing CNAV MMFs to establish the NAV Buffer. That transitional period allows for:
- 1% of the total value of the CNAV MMFs assets, within one year from the entry into force of the draft regulation
- 2% within two years
- 3% within three years
Mr El Khadraoui’s report proposed removing the three year transition period for existing CNAV MMFs to create the NAV buffer and instead requiring existing CNAV MMFs to establish and maintain the NAV buffer by 31 December 2014.
While the draft report garnered significant comment, due to time constraints in the ECON Committee in the run up to the May 2014 European Parliament elections, it was never fully debated and no formal vote on its contents occurred (a final vote in the March 2014 ECON Committee was postponed). Said El Khadraoui was not voted back into the European Parliament after the May 2014 elections and in October 2014 the newly re- constituted ECON Committee appointed Neena Gill, a British MEP, as the new rapporteur for the draft regulation.
In November 2014, Ms Gill published a new draft ECON report on the draft regulation.
Key Proposals in the November 2014 Draft ECON Report on MMF Reform
Set out below are the key proposals contained in this latest draft report.
Diversification and Concentration
The report proposes the following changes to the draft regulation:
- A financial derivative instrument traded over-the-counter shall not be eligible for investment by a MMF.
- A MMF shall not combine, where this would lead to investment of more than 5% (10% in the draft regulation) of its assets in a single body, any of the following:
- Investments in money market instruments issued by that body
- Deposits made with that body
- Financial derivative instruments giving counterparty risk exposure to that body
- A MMF may not hold more than 5% (10% in the draft regulation) of the money market instruments issued by a single body
Under the draft regulation, a MMF is required to have a prudent and rigorous internal assessment procedure for determining the credit quality of the money market instruments in which it intends to invest. The report contains a proposed amendment to this requirement such that this internal rating system should be approved by the national competent authority and communicated to ESMA beforehand. In addition, the report states that a manager of a MMF should monitor its internal assessment procedure on an ongoing basis and review all credit assessments at least every six months.
Each issuer of a money market instrument in which a MMF intends to invest should be assigned an internal rating pursuant to the internal assessment procedure.
Finally, the report proposes that in order to specify further the general principle against over-reliance on credit ratings, as introduced in the draft regulation, ESMA should develop draft regulatory technical standards to ensure that MMF managers and investors consult other sources, such as internal assessment results, and do not rely solely on credit ratings when assessing the creditworthiness of the assets held.
Ms Gill has proposed to amend the portfolio maturity requirements in the draft regulation as follows:
- At least 15% (10% in the draft regulation) of a MMF’s assets shall be comprised of daily maturing assets. A short-term MMF shall not acquire any asset other than a daily maturing asset when such acquisition would result in the short-term MMF investing less than 15% (10% in the draft regulation) of its portfolio in daily maturing assets. of its portfolio in daily maturing assets.
- At least 30% (20% in the draft regulation) of its assets shall be comprised of weekly maturing assets. A short-term MMF shall not acquire any asset other than a weekly maturing asset when such acquisition would result in the short-term MMF investing less than 30% (20% in the draft regulation) of its portfolio in weekly maturing assets.
The draft regulation contains provisions outlining how MMFs should value their assets. The latest draft report proposes some restrictions on the use of the amortised cost method for valuations in as much as it states that amortised cost accounting shall be applied only where it allows for an appropriate appproximation of the price of the instrument. The use of amortisation should be restricted to instruments with low residual maturity not exceeding 60 days and not presenting significant vulnerability to credit or market risks. Materiality thresholds of 10 basis points and escalation procedures should be in place to ensure that corrective actions are promptly taken when the amortised cost no longer provides a reliable approximation of the price of the instruments. In addition, a review of discrepancies between the market value and the amortised cost value of the money market instruments should be carried out on a weekly basis.
Under the draft regulation, CNAV money market funds may only receive external support through a specific NAV buffer and all other money market funds should be prohibited from receiving external support. The report proposes to amend the draft regulation to state that unless external support has been approved by the European Commission and ESMA, all direct and indirect external support shall be prohibited, and authorisation of a MMF should be withdrawn in the case of a breach of the ban on external support.
Specific CNAV requirements
Of greatest concern is the proposal in the report that CNAV MMFs shall operate in the European Union only as either an EU Public Debt CNAV MMF or as a Retail CNAV MMF. Accordingly, by implication, all other CNAV money market funds are not permitted. A Retail CNAV Money Market Fund means a CNAV money market fund that is available for subscription only to charities, non-profit organisations, public authorities, public foundations and natural persons. An EU Public Debt CNAV MMF means a CNAV MMF which, by 2020, invests up to 80% of its assets in “EU public debt instruments”. These are defined as public debt instruments that are cash, government assets or reverse repos secured with government debt of Member States. The draft report also contemplates ESMA developing draft regulatory technical standards specifying quantitative and qualitative liquidity requirements applicable to public debt instruments and quantitative and qualitative credit quality requirements applicable to public debt instruments.
Liquidity fees and gates
In addition, the report introduces the concept of liquidity fees and gates, but only for MMFs other than an EU Public Debt CNAV MMF. The obligation is to establish, implement and consistently apply a prudent and rigorous assessment procedure for determining weekly liquidity thresholds for the relevant MMF. In circumstances where the weekly maturity of assets falls below 30% of the total assets of the MMF, the management and the board of the MMF shall notify the competent authority and ESMA and the competent authority and ESMA shall document a well reasoned assessment of the situation and, in those circumstances, the competent authority and ESMA can determine whether to apply one of the following measures:
- Liquidity fees of up to 2% on redemptions
- Redemption gates which limit the amount of shares or units to be redeemed on any one business day to 10% of shares or units in the MMF for any period up to 15 business days
- Suspension of redemptions for any period up to 15 business days
- No immediate action
Similarly, where the proportion of weekly maturing assets falls below 20% of the total assets of the MMF, once the board of the MMF advises the competent authority and ESMA, the competent authority can determine to impose:
- Liquidity fees of at least 1% and not exceeding 2% on redemptions
- Suspension of redemptions for a period of up to 15 days
It is further proposed that when, within a period of 90 days, suspensions exceed 15 business days, a Retail CNAV MMF shall automatically cease to be a Retail CNAV MMF and shall be prohibited from using the amortised cost or rounding method.
Clearly therefore, fees and gates are only contemplated for MMFs other than EU Public Debt CNAV MMFs. The protections afforded in respect of an EU Public Debt CNAV MMF shall be the requirement to establish and maintain a capital buffer of up to 3% of that fund’s assets. However, that 3% shall only be calculated as a percentage of the proportion of assets not invested in government debt.
The ECON Committee has indicated that any proposed amendments to the latest draft report will be submitted by 11 December 2014. The draft report, and any proposed amendments, are due to be considered by the ECON Committee at its January meeting and a provisional vote by the ECON Committee has been scheduled for February 2015. A vote on the draft regulation by all Members of the European Parliament has been tentatively set for March 2015.
The Council published its first compromise text to the draft regulation dated 10 November 2014 and importantly proposed the removal of the requirement for CNAV MMFs to establish the NAV Buffer. In addition, the Council introduced the concept of a retail and small professional money market fund to which certain protections may be imposed such as imposing liquidity fees of up to 2% on redemptions, redemption gates that limit the amount of shares or units that can be redeemed on any day, or suspension of redemptions for up to 15 days. The Council compromise text will be considered further by the Council in due course.